Is the New Tax Law Lowering Home Values?

The mortgage interest deduction (MID) allows homeowners to deduct the amount they spend annually on the interest on their mortgage. Because mortgages are structured so that borrowers pay more interest than principal in the first half of the term of their mortgage, the MID is most valuable to first-time home buyers. Since 1913, the MID has helped generations of American families achieve the American Dream of owning a home.

By 1986, the MID had become so popular with homeowners and such a sacred cow in Washington that President Reagan, as he prepared for the most sweeping tax reform legislation in a generation, pledged that he would “preserve that part of the American dream which the home mortgage interest deduction symbolizes.”

Last year, the MID wasn’t so lucky. By doubling the size of the standard deduction and limiting the amount of state taxes that a taxpayer can deduct to $10,000, the number of homeowners using the MID is expected to fall from 32.3 million in 2017 to 13.8 million in 2018, a 57 percent drop. The new cap of $10,000 on state taxes will have a greater impact on homeowners who live in states with higher taxes, mostly in Pacific Coast and Northeastern states. Rather than itemize their deductions and take advantage of the MID, millions of homeowners will choose to take the standard deduction, now worth $24,000 on a joint return. Some 61 percent fewer of all taxpayers are expected to claim itemized deductions in 2018 compared to 2017. The new law also lowered the limit of deductible mortgage debt that a taxpayer can claim from $1 million to $750,000.

Reduced Demand Will Lower Values or Reduce Price Increases

Millions of homeowners who bought homes expecting to save a few hundred dollars each year thanks to MID may end up paying the same federal income tax as they would if they were still renting. Because the MID is now worthless to these families, it’ll no longer be an incentive to buy a home. Real estate interests that support the MID, notably the National Association of Realtors (NAR), argue that reduced demand will lower home values.

As a result of the new legislation, NAR projected slower growth in home prices ranging from one to three percent in 2018, a marked slowdown from the five to seven percent annual gains of the past five years.

Price appreciation over the year would vary. Colorado (5.9 percent), Utah (5.7 percent), and Arizona (5.6 percent) are expected to be the states that will experience the strongest price gains in 2018. Some local markets, particularly in high cost, higher tax areas, will likely see price declines as a result of the legislation’s new restrictions on mortgage interest and state and local taxes such as New Jersey (-6.2 percent), District of Columbia (-4.8 percent), and New York (-4.8 percent).

Are Home Values Responding?

Most taxpayers don’t change their behavior in response to changes in the tax code until they file their taxes for the first year the changes take effect. With 2018 ending in a few weeks, it’s premature to assess whether NAR’s predictions on price increases will come true, but it’s worth taking a quick peek at current trends.

There’s some evidence that consumers expect the NAR forecast to be true. A March 2018 analysis by Apartment List, a rental listing site, found that the changes in the tax code will amount to a shifting of incentives that will make home ownership less attractive. Not surprisingly, home ownership in states with higher taxes will suffer the most.

A summer survey by ValueInsured, a company that insures homeowners against loss of equity and down payment, found that one third (33 percent) of homeowners surveyed believe new tax laws that could decrease potential tax credits for homeowners and make home ownership more expensive would trigger lower prices. A follow-up survey taken at the end of the third quarter found that 67 percent of homeowners expect a home bought in their neighborhood today will likely decrease in value one year from now.

“The ValueInsured Survey revealed some concerning evidence about the changing psychology of the housing market,” said Robert Schiller, the Nobel Prize-winning economist. “We will be watching these numbers as they unfold over the future.”

Market conditions over the nine months following the passage of the tax act seem to confirm the NAR forecast for the year. October existing home sales trailed sales in October 2017 by 5.1 percent after six straight months of decreases and prices in October were up 3.8 percent over the previous year, almost the one to three percent appreciation rate NAR forecasted in February and much less than the 5.5 percent price increase a year earlier.

From today’s perspective, it’s hard to sort out exactly how much impact the changes to the MID are having on today’s housing markets. Lack of affordability, a three-year inventory drought, and macroeconomic factors like slow income growth may be more important to sales and prices. In time, the picture will become clearer.

Steve Cook is editor and co-publisher of Real Estate Economy Watch. He is a member of the board of the National Association of Real Estate Editors and writes for several leading Web sites, including Inman News. From 1999 to 2007 he was vice president for public affairs at the National Association of Realtors.